Oil prices may fall in ‘knee-jerk’ move if Fed tapers

Benchmark crude prices may encounter an initial bout of "knee-jerk" selling – with U.S. futures possibly testing $95 a barrel and Brent sliding to $107 – if the Federal Reserve starts cutting stimulus measures as early as this week, traders and strategists told CNBC.

But any weakness is expected to be short-lived and prices may soon rebound as markets adjust to the view that the U.S. economy is on a more stable footing, enabling the Fed's monetary support to be withdrawn.

"Tapering will likely trigger an initial fall on basic liquidity concerns and a move in response to the dollar presumably rising," Mark Keenan, head of commodities research for Asia at Societe Generale, told CNBC in emailed comments on Friday. The initial move lower will likely be "followed by price strength as the prospect of nascent economic growth returns - this period will be a good buying opportunity."

"We could see the usual knee-jerk reaction to the downside" if a Fed taper occurs this week, said Saxo Bank's head of commodity strategy Ole Hansen. "But taper will be introduced because economic growth is returning and what oil needs first and foremost is actual demand which it will get if economic activity rises."

Hansen has a 'neutral' call for the oil market and expects U.S. crude futures to trade between the bank's "preferred near term target area" of $96 and $99 a barrel.

Kirk Howell, portfolio manager at Allston Holdings, forecasts a move in U.S. futures towards the mid-nineties in the event of a taper while increases in U.S. refined product inventories and technical resistance at around $100 may accelerate a move lower.

"A technical failure for WTI (West Texas Intermediate, the oil grade denoting the U.S. crude futures benchmark), likely Fed tapering and the DOE (U.S. Department of Energy) product builds have me bearish for the week and looking for a retest of $95," he said.

Meanwhile, Brent crude - WTI's competing benchmark - may slip by about $2 a barrel from current levels before attracting buyers, said David Nevin, an energy broker at Tower Broking in London.

"Brent may see some sellers especially if we see the Fed taper, though expect buying around $107.00," Nevin said. "For the upside, we need to break $110.50 to move back towards $112."

'Short-term effect'

A Nomura client survey published last week showed a 37 percent possibility of tapering at this week's meeting of the Federal Open Market Committee (FOMC), which was higher than the Japanese brokerage was expecting.

A Reuters poll of more than 60 economists taken last week showed thirty-two economists expect the U.S. central bank to act in March. Twenty-two said it would scale back its monthly bond-buying program in January and only 12 economists expect an announcement next week.

"A reduction in asset buying by the Fed should only have a short term effect on the oil market," said Thina Margrethe Saltvedt, senior macro oil analyst at Nordea Markets in Oslo. "Tapering should be a positive sign…as economic growth is one of the main drivers of oil demand."

IG Markets' latest positioning data shows out of their 51 to 250 clients with open positions, 66 percent expect Brent crude prices to fall while 51 percent of their clients expect U.S. crude to rise.

Brent-WTI spread

From a supply standpoint, respondents are becoming more optimistic that a chronic U.S. inventory overhang - most visibly in the Midwest – will start easing as more downstream capacity is added, draining the glut and narrowing the price spread between Brent and WTI. Brent's premium to U.S. benchmark West Texas Intermediate (WTI) hit more than $19 at the end of November and currently stands at around $12.

Transcanada said earlier this month that it has begun filling its new 700,000 barrel per day Gulf Coast pipeline with oil, Reuters reported.

SocGen's Mark Keenan said the spread should average $9 a barrel next year: "It is starting to approach levels now that are more reflective of the underlying fundamental landscape in the U.S.," he said. UBS commodity strategists believe the differential will narrow to $5-7 a barrel over the coming months.

'Neutral'

A larger than average proportion of this week's poll respondents - one-third (9 out of 27) - are price 'neutral', reflecting expectations that the market will eventually stabilize towards the end of the trading week, even in the event of a Fed taper.

U.S. dollar gains - if the Fed does act this week - combined with perceptions of economic strength necessary for the Fed to start removing stimulus support, may simply "cancel each other out," said Simon Grose-Hodge, head of investment advisory at LGT Bank Singapore, who has a 'neutral' short-term view on oil prices.

Bullish respondents say although improvements in U.S. economic numbers will help drive energy demand, the oil and gas supply boom in North America will continue to stifle upside price movements.

U.S. crude oil production, rejuvenated by the advent of 'fracking' shale formations, will approach historic highs by 2019, the Energy Information Administration (EIA) said on Monday, raising its forecast to levels that would have been unforeseen just a few years ago.

While crude markets are gearing up for "U.S. growth-mode pricing," said David Lennox, resources analyst at equity research firm Fat Prophets, "adequate supply will cap rallies."